The term ”minerals” can be used in a variety of contexts and can vary from state to state. The term can include a wide variety of valued natural resources from fossil fuels to gemstones. Within the Marcellus Shale area, when discussing mineral rights or the leasing of minerals, natural gas is generally the mineral of interest.
Mineral rights are the rights entitling a mineral owner to extract a mineral from the earth or to receive payment, in the form of royalties, for the extraction of specific minerals. Mineral rights are an integral part of property ownership. Mineral property is considered a real property much like surface property — it can be retained, transferred and leased in whole or in part. In the states of Pennsylvania, West Virginia and New York, it is possible to own the mineral rights of a property without owning the surface rights.
Owning a piece of property does not automatically mean you own the mineral rights. There are many cases where the original owner sold the surface rights, but retained the mineral rights. A search of your deed or property title can disclose whether you own your minerals. If your current deed does not specifically discuss minerals, you may need to look back through the deeds of previous owners. This is why title searches are necessary to confirm mineral ownership.
A mineral lease is a legally binding contract that gives an energy company the right to extract and produce the mineral owner’s natural gas. Typically, the owner of the mineral rights is paid a sum of money (the bonus) when such a lease is signed. Then after a well is drilled, the mineral owner will receive a recurring payment based on the percentage of a well’s production and on the amount the operating company is paid for the natural gas, referred to as the royalty.
The basic lease agreement involves an initial bonus payment for signing the lease, a royalty percentage to be paid if natural gas minerals are found and produced from the property, and a time frame within which the energy company has to begin operations. If natural gas production occurs, the lease continues in effect for as long as the well produces, which could be decades.
Commonly, the term bonus refers to the up-front money paid to the owner of the mineral rights in consideration for signing an oil and natural gas lease. It is generally calculated on a per acre basis and the amount paid depends on the amount of mineral acres owned by the lessor.
A royalty is a percentage of production based on the proceeds of the sale of the gas . Royalty payments start after natural gas is produced and these payments continue for the life of the well.
Bonuses are generally calculated on a per acre basis, so your property size may be a factor. Other factors may include availability, accessibility and cost of surface drillsites, offset production and competition, anticipated gas production in your area, access to seismic testing, proximity of pipelines and production results in your area. The number of factors that are considered when determining royalty and bonus amount offers can differ from one individual to another within a given area.
Royalty payments begin only if your property is placed in a producing unit — meaning when and if natural gas is actually produced and sold. The time from lease signing to mineral production can range from months to years, and is determined by a variety of factors. While the bonus money is attractive because it is immediate and tangible, the royalty income can be much more substantial as it can last for decades. To learn more about the factors involved when considering the lease of your mineral rights, click here.
There are numerous factors to consider before and during the leasing process. The main consideration is to discover who will ultimately be producing your minerals, regardless of which company offers you the lease. The operating company is the one that will actually drill and produce your minerals. This could but not necessarily be the same company that offers you the lease. Also consider the reputation and stability of the leasing company, the volume of leases they have generated in this market, the company’s relationship to the mineral producer and its commitment to the community as demonstrated through corporate contributions or civic service.
Before entering into an agreement, learn as much as you can about the individual and/or business that is offering to lease your minerals.1
Well-established companies with proven track records and drilling success rates will generally produce a better well, which means more royalty income for you.
Typically, lease brokers are individuals who work independently or for a lease acquisition company ( lease brokerage firm) on behalf of certain operators. Their job is to acquire mineral leases in a specific geographic area for an exploration and production (E&P) company to develop. Brokers may or may not be trained as landmen and may possibly represent more than one E&P company. Be sure to find out which company they represent in your area.
Though you may receive letters from several different brokers claiming to represent the same operating company, such as Chesapeake, the best way to find a legitimate broker connection is to call or visit the operating company’s website for a list of approved brokers.
Getting started is easy. If you own property in the Marcellus Shale, you can contact Chesapeake at MarcellusShale@AskChesapeake.com with your property address. A representative will contact you within 48 hours.
Chesapeake properly reports lease bonus payments as Rents in Box 1 of Form 1099–MISC. Lease bonuses are a form of rental payments, paid in advance of drilling, that give operators the right to explore for minerals and are received upon the execution of an oil or natural gas lease.
Payments to landowners are considered royalties only after the well begins producing. A lease bonus is not considered a royalty because the payment is made before natural gas production commences and is determined without regard to any possible production. A royalty represents the cash value paid based on a percentage of oil and natural gas production from the property. Royalty payments are reported in Box 2 of Form 1099–MISC.
Most land owners are concerned with the classification of lease bonus payments as royalties because of the ability to deduct depletion expense on royalty payments. According to the Internal Revenue Code §613A(d)(5), percentage depletion is not allowed on lease bonuses, and the term “gross income from the property,” for the purposes of the depletion calculation, shall not include any lease bonus, advance royalty or other amount payable without regard to production from the property. Since lease bonus payments are not subject to depletion, it is inappropriate to classify this income as Royalty Income in Box 2 of Form 1099–MISC.
For more information about reporting bonus and royalty payments, click here.
Sourcing Reference:
1 Penn State University Extension service. “Five Important Considerations in Leasing.